In a recent significant opinion, Judge Marvin Isgur of the US Bankruptcy Court for the Southern District of Texas held that a springing lien to senior noteholders, conditioned on the amount of iHeart notes outstanding, was not triggered where an iHeart subsidiary repurchased notes and left them outstanding past maturity.1 The Court rejected various creditor arguments that the notes were canceled as a matter of law, or that actions to avoid the springing lien entitled creditors to equitable remedies. This ruling had secondary results, as another group of creditors argued that the springing lien would have entitled them to an equal and ratable lien. The complicated interlocking debt structures now common in bankruptcy increasingly create these “billiard ball” interactions between different tranches of debt.
The decision not only resolved a key issue blocking confirmation of iHeart’s bankruptcy plan, but endorsed careful maneuvers by a corporation to thread between express provisions of indentures when necessary to preserve value and avoid a freefall bankruptcy. Issuers and holders are reminded to focus carefully on the express terms of indentures and not rely on broad but unstated expectations, intents or equitable doctrines.
On October 1, 1997, iHeart entered an Indenture (the “Legacy Indenture”) and issued three series of Legacy Notes. The Legacy Indenture contains an “equal and ratable” clause, which restricts iHeart’s ability to encumber certain iHeart assets unless equal and ratable liens are granted to the Legacy Noteholders.
In 2008, iHeart was acquired by two private equity firms in a leveraged buyout. In connection with this transaction, iHeart issued a series of senior debt, including certain term loans and priority guaranteed notes (collectively, the “Senior Notes”). The Senior Notes provide for a springing lien over the restricted iHeart assets if the balance of outstanding Legacy Notes fell below $500 million.
Following the leveraged buyout, the recession hit, and iHeart’s debt traded at a steep discount. In response, iHeart formed an indirect subsidiary to purchase approximately $57 million of the Legacy Notes. iHeart then split one series of Legacy Notes into two classes: $193 million that was paid and retired at maturity and $57 million that was retained by another iHeart subsidiary. iHeart obtained a new CUSIP and continued to accrue and pay interest on the retained notes.
Legacy Noteholders commenced state court litigation asserting that the Legacy Notes held by the subsidiary were no longer outstanding and the springing lien in favor of the Senior Notes had sprung and, in turn, the Legacy Noteholders were entitled to an equal and ratable lien under the Legacy Indenture. Before judgment, iHeart filed bankruptcy, and the dispute continued in the bankruptcy court.
iHeart Files for Bankruptcy
A gating issue to iHeart’s proposed plan of reorganization was whether the springing lien was triggered. To complicate matters, the Senior Noteholders had signed on to iHeart’s plan, and for purposes of the plan, agreed that no lien in their favor had been triggered, but in a separate adversary proceeding argued the contrary. The Legacy Noteholders had a simpler position; the Senior Note’s springing lien was triggered, and as a result, the Legacy Noteholders were entitled to an equal and ratable lien.
Judge Isgur’s Ruling
In a significant victory for iHeart, Judge Isgur determined that the notes purchased by iHeart’s subsidiary remained outstanding, that the springing lien under the Senior Notes was not triggered and, as no new lien arose, the equal and ratable clause in the Legacy Notes was not breached.
As a threshold matter, the Court rejected the Legacy Noteholders’ argument that, as a matter of law, “once iHeart repurchased the same debt it previously issued, that debt was extinguished upon maturity.” The Court determined that the Legacy Notes were not acquired by iHeart, but by a separate bona fide entity, and thus the rule that debt is extinguished when the owner acquires it is inapplicable. The Court also concluded that, as a matter of contract interpretation, the Legacy Notes remained outstanding under the Legacy Indenture, which includes only three exceptions to the definition of “outstanding” for (i) cancelled notes, (ii) notes for which payment was made, and (iii) notes exchanged due to loss, mutilation, or theft. None of these exceptions applied and, from the Court’s perspective, there was no other prohibition on iHeart holding the 2016 Legacy Notes past maturity.
The Court also rejected a flurry of other theories advanced by the Legacy Noteholders and the Senior Noteholders:
- Prevention Doctrine - The Legacy Noteholders argued that the Court should disregard iHeart’s acquisition of the securities and consider them no longer outstanding under the equitable “prevention doctrine.” That doctrine precludes wrongful conduct intended to thwart the occurrence of a condition precedent under a contract—here retirement of the debt triggering the Senior Noteholders’ lien and in turn the equal and ratable lien for the Legacy Noteholders. The Court rejected this argument, finding that iHeart did not purchase Legacy Notes solely to thwart the triggering of the springing lien. Instead, the Court accepted testimony of iHeart executives that the debt was purchased to delay an iHeart bankruptcy filing and facilitate constructive creditor negotiations. The Court concluded that “when the purpose of the avoidance of maturity was legitimate and in good faith—such as avoiding the need to file a freefall bankruptcy case—the equitable doctrine of prevention will not be applied.”
- Unjust Enrichment - In agreement with iHeart, the Court concluded that an unjust enrichment claim is barred by the “express contract rule” which prohibits applying any quasi-contractual remedy contrary to the express terms of the Indenture.
- Equitable Lien and Constructive Trust - The Legacy Noteholders argued that an equitable lien or constructive trust should be imposed to correct an injustice. As the Court found the Senior Noteholders neither received nor were equitably entitled to a springing lien, it found no injustice to be cured by granting an equitable lien or constructive trust to the Legacy Noteholders.
- Tortious Interference - The Court rejected a claim by the Legacy Noteholders against iHeart’s subsidiaries for tortious interference alleging that the Legacy Noteholders were damaged because the new Senior Notes were issued in breach of the Legacy Indenture. The Court concluded that this claim failed as a matter of law because tortious interference cannot occur as a result of the “internally coordinated conduct” of a corporation and its subsidiary where the interests of such entities are aligned. Moreover, the Court had earlier observed that the equal and ratable lien provision in the Legacy Notes was not a bar on future liens, only a provision governing the results.
During the evidentiary hearing, Judge Isgur predicted that no matter how he ruled, appeal would follow. In the end, the Court’s decision had the opposite effect—instead of prolonging the dispute, just two days after the decision was rendered, iHeart reached an agreement in principle with the Legacy Noteholders, and shortly after, the plan was confirmed. Judge Isgur’s ruling should provide comfort to managers consciously threading their way through express terms of indentures, and give pause to creditors relying on broad unstated expectations. Careful drafting will continue to matter.